State of the Economy – June 2011

I follow economic predictions and news every morning and I have to say that during the past months the general tone has taken a major dip. We have countries in Europe and Asia falling into recession. Greece will default… it is not a question of if, rather when and how. The Euro zone will be tested over the next 12 months. If the Euro get’s through this with enough member state support and political will, then the Euro will last. A total crash is unrealistic, but even a reduction in size (very possible) will impact the long term valuation of the Euro in a way that will dwarf the cost of bailing a couple of nations.

The root of the Euro zone problems are not in the last recession, but rather in the birth of the Euro zone itself. The monetary union opened up markets and over a short period of time brought living standards, consumer pricing and wage expectations on an equal footing across the zone. This if anything was a bubble created on a dream of politicians. A crash was inevitable. I am sure that the stronger member countries benefitted from the rapidly expanded markets… now its time to pay the bill. I wont even comment on how China has benefitted and what their portion of the bill should be.

In Asia, Japan will rise through massive reconstruction investment by the government. China already proved in the last recession that they can drive growth in the short term through domestic consumer spending. China has fueled their growth with export revenues smartly reinvesting those gains. China is probably the most capitalistic country on the planet, but rather than a nation, should be viewed as a massive corporation, with a management team and a board of directors, with a long term vision. Smaller countries in APAC have grown organically; maybe too fast. Unlike in some Euro zone countries, organic growth is more adaptive to fluctuations, so I am not too concerned about APACs ability rebound quickly.

The US market is harder to predict. US companies have shown strong growth with the weak dollar boosting revenues. Detroit’s auto industry has made a robust recovery and is showing innovation that was lacking during the era of one size fits all truck and minivan. US recovery is slowed down by high unemployment and lack of rebound in the housing market. US household savings are still in their homes. This will not change in our life times. Home prices must rise for the US family to rise. I’ve said it many times and I will say it again. Unemployment is structural and requires retooling on a massive scale. US companies have room to grow without hiring. We need new industries and new industries need new skills. We can import those skills (and loose a generation) or we can retrain the work force.

Georgia recently changed its immigration laws imposing punitive measures on the employers of illegals. This is a trend that is washing over the southern and agricultural states. Farming has largely run on seasonal immigrant workers. Some could argue that the use of immigrant laborers has been a version of modern day slavery; workers without unions, minimum wage protections and/or workers rights. Yet this has provided work for hundreds of thousands of Mexicans funneling wealth to Mexican boarder communities, raising living standards and improving the overall Mexican economy. This ‘arrangement’ has also served as an undocumented agricultural subsidy enabling US consumers to enjoy lower cost groceries, which has increased disposable income in families. Georgia is now facing 50% loss in the seasonal work force pool. Some states that have gone before Georgia have seen unemployment reductions, but this will reduce farm margins forcing inflationary pressure of farm produced goods. Illegals are on the move and over the next few years will flow from state to state until immigration reform catches up on a national level. This migratory pattern will cause massive societal pressures and I think that the current administration is being short sighted in not seeking more compromise between proactive states in instituting national immigration reform.

We still need easing, not in the form of free money, but in the form of massive federal investment into the future. Free money is merely protective of existing institutions and is not flowing deep down enough to spur entrepreneurship and innovation. Federal investments require unprecedented oversight and transparency. Regional pet projects are a form of political capital in Washington, which is used for trading and bartering of votes. This will never change, but the reality is that most regional pet projects, if compared on a national level, do meet any reasonable criteria for long term return on investment. Over a longer time span investment needs to be spread geographically, so that we don’t kill smaller cities and rural areas. This would not serve a national interest. I would not remove ‘pork spending’, but rather issue a moratorium on ‘pork’ for a period of four years (next Presidential term). The next administration should them reinvest that ‘pork’ into national infrastructure initiatives with a higher return on investment.

The oil sands of North America and natural gas deposits are America’s energy trump card. When the national average of petrol prices at the pump exceeds $4 per gallon, political will starts to grow through complaints from constituents. OPEC has been good at playing on the edge by allowing oil prices float past that invisible line long enough to boost profits, but not long enough for major change to take hold. Over time the balance will shift and the OPEC oil monopoly will weaken, but before that happens countries like Saudi Arabia will have benefitted billions of dollars and reformed their national economies and energy policies for a new millennium. The oil price equation was simply about supply and demand, then we would see much faster change, but the equation has to take into consideration also international security concerns. Oil revenue is vital for reforming the Arabian peninsula and without reform this springs revolts will seem small in comparison. Rationalizing the situation, consumers in the developing countries are paying fair price for the natural resource and at times a premium for relative peace and security. As in any equation there is the human condition and one can question if the current leaders have reform or personal wealth accumulation at heart. The altruistic nature and dictatorial empowerment of ancient Greek democracy are so hard to find these days.

To wrap this article up, I predict that we will see a global correction in the fall. This will be short and will provide a needed cleansing for building a stronger and more sustainable recovery (especially for the housing market). I do not predict a recession in the US economy, but I do predict that we will see really poor growth in the third quarter. Corporations need to look beyond 2H FY11 and continue investing into FY12 growth.